TSB forced to rely on loyalty of investors: Improved profits still far short of 1986 levels

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The Independent Online
THIS Thursday, TSB Group will unveil a minimal increase in its dividend, despite predictions that it has returned to real profits for the first time in several years.

The TSB's poor showing comes in the wake of a glittering performance by the Royal Bank of Scotland, which kicked off the reporting season with a 25 per cent hike in its payout. Ironically, however, even the modest 5 or 6 per cent uplift widely expected by the City may receive glowing endorsement from some analysts, relieved that the worst of the TSB's troubles appear to be over. After pre-tax profits of pounds 6m in 1992 and a loss of pounds 47m in 1991, profits in the region of pounds 247m- pounds 300m will seem like an extra sixpence to Mr McCawber - riches indeed.

The biggest factor in this turnaround is the decline in bad debt - from pounds 575m to pounds 335m - as insolvencies and liquidations fall. A report last week from Touche Ross put the number of business failures at 3,226 in 1993, 43 per cent down on their 1991 peak. This improvement has been accompanied by a fall in mortgage arrears, with losses in TSB's Mortgage Express division expected to run at some pounds 27m, less than half their level the previous year.

But a glance at its position relative to that of the other banks shows the TSB can hardly afford to sit back. Its market value is currently 4.5 times operating profits of pounds 702m. By contrast, Barclays is capitalised at 3.4 times operating profits of about pounds 2.6bn, and National Westminster at 3.8 times profits of about pounds 2.3bn. By 1995, the overvaluation of the TSB is projected to become even larger, as operating profits reach a multiple of five times market capitalisation - a full point above the sector average.

Moreover, the TSB can hardly be said already to have rewarded the faith of its 1.25 million shareholders, many of them Sids who bought stock when the bank was floated in 1986. As Tim Clarke, banking analyst at Panmure Gordon, points out, the intervening seven years have seen shareholder funds and reserves fall by 24 per cent to pounds 1,651m, while group net asset values have dropped by 4p per share. Despite this, the group has tripled advances, substantially increasing its exposure to risk.

Pre-tax profits remain broadly the same. In 1986, they were pounds 238m; at pounds 280m - the industry consensus for 1993 - the rise in the meantime would be 17.6 per cent. With inflation running at 41.6 per cent for the period, the TSB has delivered a real fall of 24 per cent. 'Even if it makes profits of some pounds 400m in 1994, it will have spent five years getting back to where it was in 1988, with profits of pounds 445m,' says Mr Clarke.

At the same time, the share price has more than doubled, to more than 240p last week. But from 1986 to 1992, it vacillated between the 100p issue price and the occasional high of 150p. The recent surge - to a premium of more than twice its net asset value - reflects market hopes that the TSB is a recovery stock, although, with a p/e ratio of 10 and falling market yield, the recovery is already in the price.

Shareholders have further cause for disappointment when they recall that the TSB is still saddled with Hill Samuel, the merchant bank it acquired in 1987 along with the equally disastrous Target Life. 'TSB had been a rather dozy institution for 150 years. It suddenly got an extra pounds 1.5bn of capital (on its flotation) and went mad,' says one critical analyst.

Quiet intimations that it would not be averse to selling Hill Samuel were ended in December, however, when the TSB admitted that it had taken the merchant bank off the market. The share price promptly rose 7p, although it is hard to see why. As Martin Hughes, banking analyst at Credit Lyonnais Laing and one of the more bearish commentators, says: 'In the 1980s, Hill Samuel wasn't a very good merchant bank. It has stayed a not very good merchant bank.'

Mr Hughes points to other concerns. 'The TSB has the highest domestic margins in the sector, but the mix of business suggests that it should have below-average margins,' he says. Given low inflation and low interest rates over the next few years, group net-interest margins will fall by at least 20 per cent in the next two years. As a result, he has downgraded earnings forecasts to pounds 427m for 1994 and pounds 476m for 1995.

Reinforcing his perspective is the programme of disposals that will likewise dilute the group's earnings. Although it has been unable to sell its great 'Hillstone', the TSB has sold Eurodollar and Swan National, both counter-cyclical earners offering a decent return on capital.

For these reasons, Mr Hughes has also reduced his dividend expectations. 'Rather than being supported by a simple earnings bounce, the dividend burden must be considered against the level of capital. The present annual dividend cost - 7.2 per cent of core capital - is the sector's second highest, and compares with a norm of 4.5-5 per cent,' he says. In order to lift the payout, the group would have to disperse capital at a level that might not be prudent - apart from eliciting the unwelcome attentions of the Bank of England.

The great dividend debate - with the corresponding danger of depressing the share price - is familiar to many a company. But the TSB risks being damned if it does, and damned if it doesn't on almost every count. It has spent the past six years trying to recover from the disastrous splurge of 1987. Under the most recent change of management, it has decided to return to its roots. Peter Ellwood, the latest in the quick-change routine of chief executives, has accelerated this disposal programme. Now, however, some City commentators suspect that, having bought at the top of the market, the TSB is compounding its errors by selling at, or near, the bottom.

Many more errors and the group many itself be for sale. At present, however, the premium on its price and its loyal shareholders look likely to provide it with its best defence.

(Photograph omitted)